The 5 C’s of Credit: What They Are, How to Build Them

The five C’s of credit (character, cash flow, capital, conditions and collateral) affect your business financing options.
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Written by Rosalie Murphy
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The five C’s, or characteristics, of credit — character, capacity, capital, conditions and collateral — are a framework used by many lenders to evaluate potential small-business borrowers.

Each of the five C’s plays into what small-business loans you can qualify for. But different lenders may place more value on one characteristic than another. Because there are no strict guidelines, it can be helpful to understand your business's relative strengths and weaknesses — especially since factors like rising business loan interest rates are out of your control.

Here are the five C’s of credit and some tips for putting your best foot forward with each.

The five C's of credit

  • Character.

  • Capacity/Cash flow.

  • Capital.

  • Conditions.

  • Collateral.

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1. Character

What it is: A lender’s opinion of a borrower’s general creditworthiness.

Why it matters: Lenders want to see a history of on-time and full debt repayment.

How it’s assessed: From factors like your credit history, credentials, references and interaction with lenders.

How to strengthen it: Know what lenders will see with your personal credit, which will likely be the most important part of this C. Your personal credit offers a quick look at your history of borrowing and repaying money. Lenders want this information because most will require you to personally guarantee the debt — meaning you have to repay it if your business can’t.

If you’re unsure about your personal credit, you can review your reports for free once a year at AnnualCreditReport.com. You can also get a free score online from multiple places, including NerdWallet. If you need to build your personal credit, strategies to do so include getting a secured credit card or credit-builder loan and keeping your credit utilization relatively low.

Growing your business credit score can help with character, too (a straightforward first step might be to get a business credit card). Business credit is based on your company's history with debt repayment, not your personal history. It can give lenders an additional piece of information that supports your company’s creditworthiness, even if they don’t know your personal reputation.

You can help a lender understand that reputation by establishing a relationship with them over time. Typically, this is easiest to do if you use a small-business bank, in particular one with a local or community presence. Bankers who know your business’s history — and your personal reputation — may be more willing to work with you even if your other C’s are less strong.

How to work around it: Online lenders tend to place a higher premium on your business finances and may have more wiggle room around personal characteristics like credit score.

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2. Capacity/cash flow

What it is: Your ability to repay the loan.

Why it matters: Lenders want to be assured that your business generates enough cash flow to repay the loan in full.

How it’s assessed: From financial metrics and benchmarks (debt and liquidity ratios, cash flow statements), credit score, borrowing and repayment history.

How to strengthen it: If you’re focusing on bank business loans, pay down debt before you apply to free up more cash flow.

If your cash flow is strong but your other C’s are lacking, consider cash flow loans, which prioritize this factor when reviewing your application. Cash flow lenders may want to review documents like your bank statements and merchant accounts, but give less weight to your credit history or time in business. These loans are most commonly available from online and alternative lenders and tend to have higher interest rates than business term loans.

How to work around it: Is your cash flow uneven? A business line of credit or business credit card might be a good next step. These financing products let you borrow a little money at a time, pay it off and pay interest only on what you’ve borrowed. And repayment may be easier to manage than the fixed payments most term loans require.

3. Capital

What it is: The amount of money invested in a business by its owner or management team.

Why it matters: Lenders are more willing to offer financing to owners who have invested some of their own money into the venture. It shows you have some skin in the game, so to speak.

How it’s assessed: From the amount of money the borrower or management team has invested in the business.

How to strengthen it: Nearly 70% of small-business owners use personal savings to start their business, according to a 2023 survey from the U.S. Chamber of Commerce.

Make sure you categorize any personal investments in your business accurately in your accounting software, so you can keep track of them later.

How to work around it: You don’t need to immediately funnel your life savings into your business. Startup business credit cards can be a useful tool for building your business early on — though you will likely be personally on the hook to pay off any balance your business can’t. Once you have six months to a year in business, you’ll start to qualify for additional startup business loan options.

4. Conditions

What it is: The condition of your business — whether it is growing or faltering — as well as what you’ll use the funds for. It also considers the state of the economy, industry trends and how these factors might affect your ability to repay the loan.

Why it matters: Operating under favorable conditions can help ensure businesses repay their loans. Lenders aim to identify risks and protect themselves accordingly.

How it’s assessed: From a review of the competitive landscape, supplier and customer relationships, and macroeconomic and industry-specific issues.

How to strengthen it: You can’t control the economy, but you can try to plan ahead. Although it might seem counterintuitive, apply for a business line of credit before you need it, when your business is strong. That will give you access to flexible financing down the road if your business’s conditions change.

How to work around it: It’s understandable to feel stressed when your business hits a rough patch, and you might want financing fast as a result. But when this C is a weakness, it’s especially important to take your time and shop around because you’ll have fewer financing options and they may be more expensive.

5. Collateral

What it is: Assets that are used to guarantee or secure a loan.

Why it matters: Collateral is a backup source if the borrower cannot repay a loan.

How it’s assessed: From hard assets, such as real estate and equipment; working capital, such as accounts receivable and inventory; and a borrower’s home, which also can be counted as collateral.

How to strengthen it: Understand what options you have to collateralize. While real estate is common, you can also secure a loan with equipment, inventory, accounts receivable, vehicles or other business assets.

Many lenders also file a UCC lien, which gives them the right to seize a borrower’s assets if they default on their loan. Picking the right business structure can help protect your personal assets from a lender that is trying to collect.

How to work around it: SBA loans and business bank loans generally require collateral. If you don’t have collateral, unsecured business loans don’t require it — though they do usually require a personal guarantee and place UCC liens on borrowers. And unsecured financing can be more expensive since it’s riskier for lenders.

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